Resources/Weekly Insights

Volume 12, Edition 22 | Juky 24 - July 28, 2023

AI – Here We Go Again!

Doug Walters, CFA

AI is the latest buzzword on wall street, and investors should be prepared to manage their FOMO while taking advantage of whatever opportunities the exuberance provides.

Contributed by Doug Walters, Max Berkovich, David Lemire,

History never repeats itself, but it does often rhyme. As the excitement in the investment world over artificial intelligence (AI) builds, we have a good idea about how this may play out. We’re not predicting the future (as we always say… we don’t predict, we prepare). Instead, this is a cautionary tale to help investors prepare for the potential coming FOMO moment.

FOMO (fear of missing out) is a common behavioral bias for investors and a driving force behind numerous bubbles. Disciplined investors know how to control their FOMO emotions and eventually capitalize on the irrationality that it drives.

We have numerous examples from history to draw upon. The dot-com bubble is a great example. All a company needed to do in the late nineties was put “.com” after its name, and its stock price would skyrocket (remember eToys.com and pets.com?). The fever peaked in 2000 when the tech-heavy Nasdaq Composite Index began a nearly 80% decline. More near-term, albeit less dramatic, examples include the blockchain craze (including crypto and NFT art). Mention “blockchain” in your earnings call, and your stock was likely up.

Today’s hot topic is AI, and a growing number of companies are using the term in their earnings statements and presentations. In a presentation last May, Google alone mentioned AI 160 times. Let the exuberance begin! With the S&P 500 up 19% and stock valuations well above long-term averages, is it time to sell? That would not be our approach. Stocks may be expensive, but market timing is a losing battle. Think about the dot-com bubble. Fed Chairman Alan Greenspan, who probably had access to more economic data than anyone on the planet, warned of “irrational exuberance” in 1996. The stock market more than doubled over the subsequent three years. Missing that would have been a difficult pill to swallow.

So if market timing is off the table, what is an investor interested in avoiding FOMO to do? Our approach is threefold:

Look for opportunities within equities. For example, Value stocks look particularly attractive compared to expensive Growth.
Capitalize on Momentum. Investors can own Momentum funds which should benefit if AI drives a protracted market rally and will automatically rebalance out of those names should sentiment turn.
Ensure you have a well-diversified portfolio and sophisticated opportunistic rebalancing that will enable you to take advantage of market swings by systematically selling high and buying low.

Investors need not fear “missing out” and need not fear the drama of bubbles and corrections. For the well-prepared investor, irrational market moves are simply an opportunity to exploit.

115%

Return of the S&P 500 after “irrational exuberance”

Market timing is a losing battle. The S&P 500 returned 115% over three plus years from the day Fed Chairman Alan Greenspan warned of irrational exuberance to the peak of the dot-com bubble.

Headline of the Week

“That’s a really good thing.”

Those are words we have not heard from Fed Chair Jerome Powell in a long time (if ever). He was referring to inflation’s apparent cooling without any collateral damage in the labor market. While everyone wants to see inflation retreat to the Fed’s 2% target, historically, the steps taken to make that happen boost unemployment, if not tip the economy into recession. An old economic adage quoted from the Wall Street Journal says, “Economic expansions don’t die of old age, they are murdered by the Federal Reserve.” So, the upbeat message from the Fed Chair stems from his relief that charges are not imminent for any economic capital offenses.

The next day we got another “good thing,” a pleasant surprise as the GDP report showed continued economic strength and provided the latest encouragement to the soft-landing thesis. While consumer spending cooled a bit, businesses picked up the slack, and housing could be the next source of strength. It is widely acknowledged that victory is not being declared, but this week’s developments were a really good thing.

The Week Ahead

Friday’s jobs report is the most important release next week. But Gross Domestic Product from Europe, a rate decision from the United Kingdom, and various Purchasing Managers Indices will provide plenty of news between earnings reports.

Work-Out

The first Friday of the new month brings the all-important non-farm payroll report.

Resilient job growth is the key factor keeping the economy growing despite 11 interest rate hikes.
A Goldilocks report is necessary; not too hot and not too cold!
Reuters poll of economists is predicting 184,000 new jobs in July.
This would be the lowest number since the pandemic recovery started, but it is still growing.
Other data to focus on are the unemployment rate and average hourly earnings.

Keys to the Kingdom

When the Bank of England announces its rate decision next week, it will be with a sub-8% inflation figure in the forefront, progress by all measures considering it peaked at 11.1%.

While markets are nearly split on the odds of ¼ or ½ percent hike, a hike is all but certain.
The British economy is clearly struggling, so a big hike may not be wise, but preparing the market for more hikes is necessary.
Inflation rates higher than what we in the United States witnessed and farther away from a similar 2% target are behind the wheel.

Thin Line

The European Union will release preliminary 2^nd quarter Gross Domestic Product (GDP) to start the week.

As in the 1^st quarter, expectations are for a tiny expansion.
With revisions in the coming weeks, a borderline positive number will weigh on the European Central Bank and keep feeding the inflation doves.

A Pill to Swallow

Another big week of corporate earnings is in store. Apple Co. (AAPL) and Amazon (AMZN) will steal all the thunder on Thursday night, but Health Care dominates this week.

On deck next week are CVS Caremark (CVS), the pharmacy; McKesson (MCK), the pill distributor; Amgen (AMGN), Regeneron (REGN), and Gilead (GILD), the biotech giants; Moderna (MRNA), Pfizer (PFE), Merck (MRK) and Novo Nordisk (NVO), the pharmaceutical makers.
Other big names to watch include Warren Buffett’s Berkshire Hathaway (BRKA, BRKB), chip maker Qualcomm (QCOM), Chinese tech goliath Alibaba (BABA), Japanese car maker Toyota (TM), and construction equipment maker Caterpillar (CAT).

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